Challenges Faced by American Vendors Operating within China
November 25, 2010, Revised March 5, 2011
This paper is written from the perspective of an American “vendor” operating in China to provide services to this vendor’s American “client”. This vendor delivers mostly one-of-a-kind goods and services, or small quantities of goods, as opposed to mass produced goods.
The purpose of this paper is to relate, based upon our own experiences, the challenges facing an American vendor seeking to procure and produce within China. The reader is assumed to be an American unfamiliar with doing business in China.
Our message may be summarized as follows: Given sufficient experience with the issues to be faced, the required quality is attainable, but not without extraordinary budget and schedule uncertainty owing to the significant variables which are not within a vendor’s control, or anyone’s control. The cost of mitigating the budget uncertainty will significantly erase the China cost advantage. The schedule uncertainty can only be addressed by building contingency into the schedule.
As with all work, quality communication is the key, but dramatically more effort must be devoted to ensuring quality communications. The following are essential:
Caveat: Although we write with five years of experience doing business in China, having delivered hundreds of unique items of equipment, particularly control systems and lighting fixtures, mostly to theme park clients, totaling U.S. millions of dollars of products and services originating from within China, there is a caveat to the applicability of our experience in China: thus far about 95% of what we have produced within China has been for export out of China. There are some differences when producing goods and services for delivery within China. Hence the specifics of some of these challenges will change when delivering within China. Undoubtedly, the broad themes of the challenges will be the same.
Topics to be addressed in this paper:
Logistics (particularly clearing Customs upon entering and exiting China) is, for us, the single most unpredictable and frustrating aspect of doing business in China. Our Chinese associate businesses feel similarly. Logistics is both the budget and schedule item most difficult to estimate.
These are some of the logistics-related issues:
A series of examples will further illustrate:
These are just a few examples. There are many others. We slowly learn new ways of avoiding problems but we can never hope to avoid all the problems because it is all so arbitrary. The details of the problems change constantly but the theme is always the same: something unexpected is wrong and it can only be fixed for a fee. There will be a delay, but fortunately the delay is usually not much longer than it takes to arrange payment of the fee.
You might wonder, have we suffered all this grief at the hands of one particular trading company or freight forwarder? No, we have worked with numerous companies, some of whom are contracted to us and some of whom are contracted to our vendor. The theme is the same regardless. Chinese vendors suffer from these problems just as much as we do as an American company. Keep in mind that this is a 90/10 thing. 90% of the shipments go through customs without a problem but the other 10% are responsible for 90% of the effort, delays, and “fees”. Mostly, it is the unpredictability that is the problem. There may be five shipments associated with a particular project but there’s a 50-50 chance that one of those shipments will become a problem and impact our ability to deliver the whole project on schedule. The only solution is to build contingency time into the schedule.
In our experience of producing control system equipment and lighting products in China, we have learned that on average we can readily procure in China about 80% of the component line items on a bill of materials. The remainder must be purchased outside of China for one of three reasons: (1) the items are simply not available for purchase in China, (2) the lead-times from the Chinese suppliers are unacceptable, or (3) the item is unreasonably expensive when purchased from Chinese suppliers. It is this 20% of the components which must be brought in from outside of China which cause the overwhelming majority of the schedule delays and unbudgeted costs, because they must pass through Customs. For these goods which come in from outside of China, the following costs can be anticipated:
In an effort to gain better control over these issues we will obtain an import-export license and hire a very experienced Chinese logistics person to work directly for us, putting as many as possible of these variables under our control.
Meanwhile another solution that we use is to work with multiple trade partners so as to identify the ones which are most effective. There must always be a contingency plan when working in China.
Currency fluctuations. Continued appreciation of the RMB seems likely. If for example we are contracted in Hong Kong dollars or US dollars, but the RMB has appreciated by the time we are in a position to make a required purchase in RMB, this would injure us. Thus to the extent that purchases must be made in RMB, we will want RMB payment terms to avoid the cost and complexity of hedging. Much of this problem can be solved by contracting with our corporation in the country where the activities and expenses will occur, and contracting in the local currency. For example, we might contract design work through our Hong Kong Corporation but contract fabrication and installation work through our PRC Corporation.
Limitations on cross-border transactions. A lengthy approval process is required to move money in or out of China. If for example a business such as ours is more liquid outside of China, and cash is needed within China, it will not be possible to move that money into China quickly. We will require payment terms which ensure that we do not get into a position of costs in excess of our billings.
Having delivered relatively little for consumption in China we have limited meaningful experience with compliance issues. We expect that there will be both local and national agencies with jurisdiction. We have one of each experience that is worth relating:
CSEI approval of a roller coaster in Beijing. We are under contract to a US roller coaster manufacturer to provide the software for fairly sophisticated high-energy coasters in four Chinese cities. So far we have only witnessed the CSEI approval process from the sidelines. The CSEI has expressed no interest whatsoever in the control system or software. Their only requirement related to the control system has been to require that the ride run for a period of days without generating any faults. We are of course in complete control of what faults the software reports. They have inquired about the faults that are reported. They have not asked for or seen any of the software development documents. It’s evident that we could choose to suppress the reporting of faults in order to pass the requirement of operation with no faults. The only “test” they performed was to press an E-Stop button to make sure that it stopped the ride – the least and most obvious of the myriad of the safety control system’s functions. On the other hand, our client reports that the CSEI has been quite involved with mechanical and particularly structural issues, although we are told that some of their concerns have been arbitrary and misdirected. There was a meeting prior to construction when our client was required to present structural, mechanical, and electrical power distribution documents to the CSEI for approval. There were no submittals required related to the control system.
We do not believe that much can be read into these observations. It could all change quickly. As is the case in all jurisdictions, it is undoubtedly wise to be proactive with the authority, if necessary teaching them what they should be looking at, and leading them through it to make them comfortable with it. We believe that we should anticipate that their level of oversight will increase.
Projection screens at the Shanghai Expo. You may have heard about this issue as it received some international press and was quite an expensive problem. There is an acoustically transparent material from which large high-gain projection screens are made. The particular material at issue has been used repeatedly around the world, including in several previous installations in China. Local authorities routinely require that the material pass a flame test, and this material has repeatedly passed that test, in China and elsewhere. For some reason, the piece of the product that was cut from two Expo theaters did not pass the flame test. As a consequence, the local authority required the installation of a very expensive deluge system at a time when schedule and access made such an installation impractical. All of those involved were convinced that the test results were in error. The US contractor with the most to lose asked if we had any ideas, if we could help to resolve the problem. I put the question to the engineer/manager of our Shanghai office. Her first (joking?) reaction was that this was probably an ornery inspector “waiting for an attractive young woman with a fistful of 100 Renminbi bills.” I then showed her a copy of the test results, all written in Chinese, of course. She quickly reported, “There is a real problem, and nothing can be done about it.” We got into quite a heated discussion. I repeatedly explained that there is always something that can be done. I asserted that we should ask about the test criteria, the test conditions, and we should challenge the validity of the test. I suggested that an expert be hired to challenge the results. We certainly don’t begin by accepting defeat. She kept pointing to the words at the top of the page. She said “this report is generated by the China National Testing Laboratory. That means that there is no method of recourse and there is no expert who will challenge the report.” I went on with my arguments and she made some phone calls to humor me but in the end no progress was made. We heard that Secretary of State Clinton attempted to intervene (because the timely opening of the US pavilion was at risk) with no success.
If there is a lesson here for us it is that Chinese in China do not see any point whatsoever in challenging anything decided by an arm of their government, except perhaps by exercising any available close personal relationships with government officials.
Quality and Efficiency
These are some issues about which an American operating in China must be ever-vigilant:
All of these issues can be addressed with diligence.
We should remember that over the last 30 years China has optimized itself for delivering commodity products in large volume. As we all know, it seems as though everything consumed in America is made in China. In general we are not having a problem with the quality of our commodities from China. Therefore it is unmistakably true that China is completely capable of delivering the quality we expect if that expectation is properly communicated and the results are inspected.
What we do not appreciate is the magnitude of the initial effort that went into setting up those assembly lines and the extent of the quality monitoring programs that were developed to keep quality product coming off of those assembly lines. That initial cost and effort is justified by the volume. The problem with everything that we have done and will do in China is that the quantities are small, often a quantity of one. Thus the cost of the effort to attain quality is a significant part of the cost of the goods and services we deliver from China.
Bottom Line: It is necessary to provide more staff than would normally be necessary to teach, coach, and continuously inspect and monitor progress. Do not ever assume that previous successes will be repeated when nobody’s watching. This is a never ending challenge that comes at a cost which significantly erases the much-anticipated China cost advantage.
Doing business in America we generally accept that we can reliably conduct our affairs, especially our business affairs, within a framework of laws, rules, procedures and customs all of which are comparatively stable and clearly-defined – able to be learned and applied repeatedly with the same results each time. We also accept our right to appeal decisions and even to question problematic laws and rules.
To be certain, there are plenty of laws and rules within China, but there is an important difference. We’ve heard it described as “in China, rather than the rule of law, there is rule by law.” The subtle difference is that the end justifies the means. Rather than attempting to apply an immutable law to circumstances to determine the proper outcome, those who are in a position to assert themselves (public and private) establish their goals and then apply the rules as necessary to attain those goals. There is usually no clear path of appeal and it is often difficult to get the rules in writing.
We note the evolution of our own expectations over the years of learning to do business in China. In the beginning, we viewed our disappointments (failures?) as opportunities to learn and improve. Every problem is an opportunity, often just an opportunity to learn how to do better. We believed that by learning the new rules of the game, then developing new procedures and methods to operate according to those rules, we could obtain the desired results. To a degree this has worked, but we gradually have come to understand that there is a different dynamic in operation in China. Many of the rules are unwritten, deliberately un-learnable, and too frequently changing – at least the explanation of the application of the rules is always changing. Further, our Chinese business associates, those with whom we must cooperate to meet our objectives, do not always operate by the rules. The unpredictability of the application of the rules creates an environment within which avoiding and circumventing the rules becomes a sport. If you don’t play, you lose. To an unsettling degree, business is conducted in spite of the rules, by constantly maneuvering through and around the rules.
To attempt to rigidly operate by rules (or to even to attempt to fully discern the rules) is to deny oneself the full utility of those who are most able to help achieve the goals. All of this is confounding for an American attempting to do business in China until he or she learns, within the limits of what is ethical and legal, to accept and embrace the process.
When bidding work, a China-based vendor such as Birket is simply unable to budget project costs with the U.S. accustomed accuracy. The familiar dilemma – guessing low and losing money versus guessing high and completely losing the opportunity to earn money – is magnified in China. In the US, the approach to the dilemma is to make the best possible guess about costs and then add an amount for “insurance” hoping that over time the sum of these little insurance premiums are enough to cover the total incidences of guessing low. The size of the insurance premium must be a function of (1) the amount of money at risk and (2) the degree of uncertainty involved. (Admittedly the process is often more subjective than analytical, but it occurs nonetheless.) In China, both factors related to the unknowns (value and risk) are larger than in the United States, Hong Kong and Singapore, thus the “insurance premium” that is built into the cost proposal must be larger.
The building of lasting personal relationships is always key in business, but more so in China. It is important to devote time to the building of these relationships – many long meals in noisy smoke-filled rooms with plenty of 白酒 to drink.
Lessons learned doing business in Hong Kong and Taiwan are useful but not entirely applicable in the PRC. Lessons learned in Singapore are less helpful. Only a very few of the lessons learned in Japan are applicable in China. It’s important to note that the Chinese economy has evolved rapidly and recently, thus it is to be expected that the Chinese are most tied to thought processes learned in an earlier era which was dramatically different from those thought processes which are familiar to Americans.
Example: There is a small street that we walk each day from our office in Shanghai to our apartment. We have always called it “Crazy Lane” because it was such a ram-shackled mess. The city decided to redevelop this lane about a year and a half ago. First the businesses and residents were gradually relocated. Buildings began to come down, in no particular order. One would be partially demolished and then left while another was partially demolished. Then disconnected parts of a new sidewalk, curbs, and road would be built between partially demolished areas. All the while we and the hordes of people would continue walking through the evolving mess. Gradually, finally, order began to reemerge, and we could see the designer’s intent, or so we thought. The road was irregular in width, and oddly routed, and the sidewalks were wider than the road. Surely there must be a reason for this, we thought. Then, up came the new sidewalks. The curbs were jack-hammered out. New forms were put in for the curbs, then removed and relocated again. Eventually new sidewalks were put on top of what had been the new road. The road was straightened and routed through areas that had previously been the new sidewalks with telephone poles and a tree. I watched cement being poured around the base of that large tree and the telephone poles – yes, the road was routed through the tree and the telephone poles without removing them first. About a week later someone came to cut down the tree. Presumably the telephone poles will be next. Meanwhile, there is a hole in the road where there had been a tree, and three giant telephone poles smack in the middle of a brand new road, encased in cement at their base – all destined to become patched spots in an otherwise new road. Of course there are footprints and tire treads throughout the cement.
Of most concern should be that I found none of this particularly unusual as I watched it unfold over the months. Certainly none of our Chinese staff have thought any of it at all unusual.
Good reading. Of all the books I have read on doing business in China, perhaps the most practical has been “One Billion Customers” by James McGregor. It’s not just about cultivating the Chinese market. It contains a lot of wisdom and examples directly applicable to the work that we all expect to do in China. Another is “Mr. China” by Tom Clissold – older, but many of the lessons are still valid.